How to still have a merry Christmas if you're struggling with credit-card debt

American families have more debt than this time last year, and the default rate is creeping upward to levels last seen at the start of the Great Recession. Are we headed for trouble, and how can families in debt negotiate the holiday season?

If you're like many Americans, you know exactly where they are and you're preparing to use them.

Levels of credit-card debt, which declined after the Great Recession, are sneaking back up, as are rates of delinquencies and default. In May, the Federal Reserve Bank said total household debt in the U.S. was $12.73 trillion, a number that surpassed the previous peak in 2008. In August, the Fed reported that household debt had risen again, by another $114 billion, to $12.84 trillion. And the third-quarter report released Nov. 14 had household debt at a record high, $13 trillion.

The Federal Reserve numbers include not just credit card debt, but also mortgages, student loans, auto loans and home equity loans. But credit-card debt alone rose by $24 billion in the last quarter. With the holiday shopping season upon us, card balances aren't likely to shrink before the end of the year, and lenders are paying attention.

The Wall Street Journal recently reported that Citigroup's third-quarter reserve to cover credit-card losses was $400 million higher than this time last year, and J.P. Morgan has set aside an additional $330 million from last year.

Some analysts say that the steady rise in consumer debt doesn't mean the nation is speeding toward an economic cliff as it was when the housing bubble burst a dozen years ago. For one thing, the credit score of the average debtor is better than it was then, and mortgage default rates are not increasing; in fact, between July 30 and Sept. 30, new foreclosures were at a historic low.

But even if the nation's fortunes hold steady, one extravagant holiday season can edge a family with high levels of debt close to insolvency as the new year begins. And interest rates may soon rise again. If you're one of the Americans with more credit card debt this year than last, here's what you should know as the holiday shopping season commences.

House of cards

The last time American families were this much in debt was the summer of 2008, as the Great Recession was beginning.

According to the Federal Reserve, the only kind of consumer debt that is currently in decline is home equity lines of credit.

A new report by the consumer finance website NerdWallet says that 56 percent of Americans plan to use credit cards for holiday shopping this month, even though 14 percent of us haven't paid off the gifts we bought last year.

The average American has credit-card debt exceeding $8,300, analysts say. Most of us report paying off our balances each month, but those who don't may struggle to make minimum payments if their income declines, or the minimum payments required go up because we've charged more or interest rates have gone up.

That's what happened to Alex and Cassie Michael of Clearfield, Utah, whose debt spiraled out of control when they were newlyweds. As the couple recounts in their first book, published in October, Alex Michael had to take out a loan while on their honeymoon to cover the hotel bill.

By the time Cassie Michael became pregnant with their first child, the couple had more than $100,000 in unsecured debt, were four months behind on payments and were dodging calls from collection agents. The pregnancy inspired the couple to dig out of debt.

"That became our why," Alex Michael said. "It's one thing for myself, for my wife, to be in that situation, but it was another to bring a child into it."

At first they tried radio host Dave Ramsey's method of debt reduction — drastically ramping down spending and paying off debts from smallest to largest — but they decided that plan was too much like a crash diet, and unsustainable.

Instead, they decided to tackle their debt by trimming their budget a little every month while gradually raising their income, a system they later dubbed "the 2 percent rule." Doing this, they paid off $90,000 in debt in three years, while Alex Michael was working as a software engineer and Cassie Michael was staying home with their children. They now coach others on how to get out of debt.

Like many families, the Michaels were blindsided by their accumulating debt, believing that as long as they were able to make the minimum payments every month, they would be OK. But minimum payments are not fixed — card issuers can change the interest rate afterward if payments are late or if the Federal Reserve Bank raises interest rates nationwide. There's already been one rate hike this year and some analysts believe another is coming in December.

And while the U.S. economy is currently robust and unemployment is low, a change in outlook could be catastrophic for families who've built their financial house on credit cards.

"The scary thing is that when the economy inevitably takes a downturn, all of that debt gets really troublesome really quickly, and you can end up seeing a lot of people get in difficult financial straits," said Matt Schulz, senior industry analyst for Creditcards.com.

"We don't know just how high credit card debt can go without causing really major problems," for the economy, he said.

Good debt, bad debt?

For individuals who are unable to pay off their balances every month, the widely accepted rule-of-thumb for keeping credit-card debt under control is to not exceed 30 percent of your available credit, which is the point at which your credit score starts to decline.

"That is, if you have $10,000 worth of credit, you don't want to go over $3,000," Schulz says. "The overall truth is a little simpler than that, which is, you just need to keep your balances as low as you possibly can.

"That's especially true when economic times are good. If you have credit-card debt when times are good, it keeps you from being able to prepare yourself for when times are bad. You can't build an emergency fund or put money in a 401(k) when you're paying down credit-card debt."

Even as the nation's household debt climbs, many analysts say credit-card debt is unlikely to cause a national economic crisis because the economy and banks are in good financial shape, even if some individuals and families are not.

As for the best use of credit cards, many analysts say we should use them only for big-ticket items, such as furniture, to allow you to pay over time. Revolving debt for purchases such as a meal or a cup of coffee is not smart spending on a credit card.

Part of of the increase in credit-card use can be attributed to online shopping. Fortune magazine has reported that some Americans now make more than half of their purchases online, and many people believe credit cards to be the safest way to pay over the internet.

Some analysts say credit-card debt is also growing for good reasons, not because Americans are broke and using them to pay for groceries and gas. The bulk of the growth in recent credit-card debt is to people with stellar credit scores, not subprime borrowers whose inability to make their mortgage payments was at the heart of the Great Recession. As the Federal Reserve recently noted, most recent expansions in credit limits went to people with credit scores of 720 or higher.

Some people juggle multiple credit cards in order to obtain rewards, such as cash back or airline miles. Others are just now getting credit cards after losing them during the recession. (It takes 10 years for a bankruptcy to drop off your credit record, seven years for late payments.)

Credit-card issuers have been offering "unprecedented" rewards in competition for business, said Schulz of Creditcards.com, and they compete vigorously for high-end spenders, "reward chasers who have 20 cards, never carry a balance and have amazing credit scores."

On the other end of the spectrum are people who eschew credit cards completely. "That group is significant, and a lot of folks joined that group after the Great Recession. Coming out of that, the last thing they want is more debt," Schulz said.

Then there are the families who carry a balance every month "basically to get through life, because life can be expensive," Schulz said. They are increasingly vulnerable to unmanageable debt because of the growth of portable credit-card readers, such as Square, an attachment that allows anyone with a smartphone to accept credit cards as payment.

"Here in Austin, we have a food truck every 10 feet. Years ago, those would have been cash operations. Now you never have to break out a dollar bill. It's all credit-card sales," Schulz said, adding that some people use Square and other portable processors to take credit cards at yard sales.

Researchers have found that people spend more when using credit cards, less when paying with cash. This means that if you're planning on paying for Christmas over time, you may spend twice as much than if you use cash.

Celebrating Christmas without debt

For families struggling with credit-card debt, the holidays can be especially stressful, and it's already too late to adopt the two best strategies: saving a little bit of money each month and shopping at big sales throughout the year.

But you can still have a merry Christmas without incurring more debt. You may have to be creative and find ways to bring in extra money over the next few weeks. Or, you may opt a radical reshaping of the holiday, as Vermont writer Bill McKibben advocated in his 2007 book "Hundred Dollar Holiday."

McKibben urges families to drastically cut their holiday spending — regardless of how much debt they have — because he believes the focus on shopping distracts from the season's spiritual gifts.

"I think we were made for some relationship with the divine, and I think Christmas offers one of the most comfortable ways to begin and renew that relationship, at least for those of us who have grown up in the Christian tradition," McKibben wrote.

Refusing to build Christmas around the frenzy of buying restores the holiday for families who feel that "too much of the chance for family togetherness was being robbed by the pressures of Christmas busyness and the tensions of gift-giving," McKibben wrote. He recommends making gifts, employing your natural skills, and he focuses on a different type every year. One year, he made bagels studded with cranberries; another year, spicy chicken sausage; others, handmade soap and walking sticks.

Of course, children who are used to bounty under the Christmas tree won't be impressed by homemade soap and bagels, no matter how good they are.

Alex and Cassie Michael suggest two strategies for parents who are burdened with debt but still want their children to have a wonderful Christmas: buying second-hand toys from thrift shops and yard sales, and aggressively using coupons at sales.

When their daughters were 2 and 3 years old, the Michaels bought a play kitchen at a yard sale for $10 and cleaned it to look like new. Then they purchased a new, inexpensive set of play dishes and food to go along with the kitchen. Now adolescents, the girls still remember that as one of their favorite Christmases, and their main gift cost about $30 (minus $5 the Michaels later got for the kitchen when they sold it at their own yard sale).

Both McKibben and the Michaels stress that communication is important when preparing to make changes. It's important that parents communicate to their children that they are working hard to cut expenses, and to encourage each member of the family to come up with ideas on ways to save money, Cassie Michael said. Children don't need to know the details of their parents' finances, but parents can talk about the need to scale back in order to meet the family's financial goals, she said.

Even if you scale back on gifts, Christmas can still throw a budget off course with travel expenses, holiday tipping, donations to the needy, and special holiday meals with extra people at the table. The best way to get through the holidays without using credit cards is to set aside extra money all year, but if you haven't done that, there are still ways to get through December without adding more debt, the Michaels say.

To bring in extra money for Christmas, the Michaels suggest doing seasonal side gigs, such as offering to clean homes before holiday parties, or doing "drop-off" child care at your home so parents can go to parties or shop. Or go through your house looking for unused electronics you can sell for a little extra cash.

However you decide to approach Christmas spending, financial analysts urge Americans not to succumb to credit-card offers that proliferate at this vulnerable time of year, particularly those that offer a period of time with no interest or reduced interest. Such promotions can entice consumers who could be hit with staggering, accrued interest if they are unable to pay off the balance during promotional period, according to the Consumer Finance Protection Bureau.

For example, the National Consumer Law Center in Boston says that if you buy a $2,500 diamond necklace this week using a one-year, 24 percent deferred interest plan, then pay off all but $100 by the same date next year, the lender will add nearly $400 in interest to the next bill — interest on the entire $2,500 purchase for one year. And yes, that is legal.

"Deferred interest promotions are one of the biggest credit card traps on the market today. Avoid them at all costs," said National Consumer Law Center staff attorney Chi Chi Wu, author of a 2015 report on the practice.